Facebook IPO: Investors should wait

Commentary: Some red flags merit attention and scrutiny

SAN FRANCISCO (MarketWatch) — Most investors realize that unless they work for a big mutual fund or institution, they won’t likely be able to buy shares of Facebook when it makes its debut late next week.

Facebook’s
FB, -1.26%
upcoming IPO, which is expected to value the company at around $95 billion, is the biggest Internet IPO since Google Inc.
GOOG, -1.10%
went public in 2004. There even will be shares allotted to retail investors, with perhaps 20% to 25% of the offering going to retail or online brokerage firms catering to average investors and day traders. Read "How to get a piece of Facebook."

Still, the question for most investors will be whether they should buy Facebook shares after the first-day pop. The big money will have been made by top executives, such as founder and Chief Executive Mark Zuckerberg, its venture capitalists and other bigwig investors. Joe Day Trader and his brethren will have to look at the stock — after it prices and begins actual trading — and decide for themselves.

Facebook’s stunning user growth is an attention-getter

The anticipated frenzy over one of the largest tech IPOs ever is probably going to be contagious. Already, the company’s road show has been covered ad infinitum by the media — a road show that didn’t appear to offer much new information beyond the prospectus.

Leading up to the road show, which started Monday, some of the biggest speculation was about whether Zuckerberg would show up, and if he would wear a suit instead of his much remarked-upon hoodie. (He did show up, at least in New York, but he did not wear a suit.)

Facebook appeared to listen to the gripes of investors in New York, who were irked that the company wasted precious road-show time showing its slick 30-minute video — which had already been seen by many online. The company reportedly did not show the video in Boston. Read about Facebook's road show in the Wall Street Journal.

Still, it’s going to be easy for investors to get swept up in the hype. After all, nearly 1 billion people are registered monthly users of the social network. Most people know what Facebook is or they use it.

Facebook

Mark Zuckerberg: no suit for you!

I’m certainly not a financial adviser, but average investors might do well to avoid the first-day madness and instead wait and watch how the stock trades and whether it looks like it is going to be able to maintain its hefty valuation. Even the Oracle of Omaha, Warren Buffett, said he won’t be investing in Facebook. But it’s worth noting that he is also incredibly averse to investing in IPOs.

On the bullish side, though, one Wall Street analyst, Arvind Bhatia at Sterne Agee, one of the early birds to initiate coverage, started covering Facebook on Monday with a buy rating, and a price target of $45.

“Just like Google did less than a decade ago, we believe Facebook is disrupting the worldwide advertising market,” Bhatia wrote in his report.

Here are some red flags investors should pay attention to before making the big leap:

1) Zuckerberg, as we have noted before, will continue to rule Facebook with an iron grip. After the IPO, he will control approximately 57.3% of the voting power of Facebook’s outstanding capital stock. It’s a Zuckerberg dictatorship, and any bets are bets on the 27-year-old CEO.

2) Facebook’s revenue growth rate started to slow in the first quarter. While the company’s revenue of $1 billion in the first quarter is still growing, its growth rate slightly decelerated to 45%, down from growth of 55% in the previous quarter.

3) Inconsistent revenue patterns, or lumpiness, as the Street likes to say. Morningstar Inc. analyst Rick Summer predicted in a February report that “despite our bullishness, we expect a lot of volatility in Facebook’s revenue growth rates, which may translate into stock price volatility,” Summer wrote. “Even looking at historical quarterly revenue growth, the lack of consistency is notable.” Read John Shinal on Facebook's "lumpiness"

Is the Facebook IPO Doomed?

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MarketWatch's Dave Callaway pulls up a chair on Mean Street and points out that global economic instability could pose a substantive challenge to this month's scheduled Facebook IPO. Photo: Reuters.

4) Facebook is not as pervasive yet on mobile devices, especially smart phones, as it is on PCs. The company’s $1 billion acquisition of the photo-sharing app company, Instagram, was an indication that mobile is a bit of an Achilles heel. In March, the company had 488 million monthly users of its mobile products, according to its most recent regulatory filing.

Bhatia at Sterne Agee believes that mobile will be a “significant long-term growth opportunity for Facebook, but with some initial challenges,” he wrote. “For example, it is not yet clear if most of the mobile advertising growth will be incremental or will cannibalize online advertising.”

5) As younger startup companies develop competitive threats to Facebook’s dominance in social networking, the company may use its cash and stock to acquire them. Analysts have speculated that based on its recent deal with Instagram, it is not inconceivable that Facebook, which doesn’t yet have a long track record doing acquisitions, could also acquire other fast-growing startups, such as Pinterest or Tumblr. Read about Facebook's potential for more deal-making.

Those are just a few things to be watching for as Facebook goes public. Perhaps a theme song for the more bearish minded investor during this closely watched IPO could be Public Enemy’s hit, “Don’t Believe the Hype.”

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